Gambler's Ruin

Berkshire Hathaway Annual Meeting '09 - It's not a company but a culture, maybe a cult

2009-05-28T12:30:00.000-07:00

“Although our form is corporate, our attitude is partnership.”

I had the opportunity and privilege to attend the annual meeting of Berkshire Hathaway which is held in Omaha, Nebraska every year around the first weekend of May. This year the meeting was on May 2nd and was held as it has been for the past few years in the Qwest center in downtown Omaha. The meeting was attended this year by about 35,000 shareholders, the most ever. One of the reasons people attend the meeting, including myself, and make the trek to Omaha, Nebraska is the fact that is emphasized by Warren Buffett in the Berkshire Hathaway owners manual.

"Charlie and I hope that you do not think of yourself as merely owning a piece of paper whose price wiggles around daily and that is a candidate for sale when some economic or political event makes you nervous. We hope you instead visualize yourself as a part-owner of a business that you expect to stay with indefinitely, much as you might if you owned a farm or apartment house in partnership with members of your family. For our part, we do not view Berkshire shareholders as faceless members of an ever-shifting crowd, but rather as co-venturers who have entrusted their funds to us for what may well turn out to be the remainder of their lives."

I can personally tell you that the feeling of ownership and entrepreneurship was alive and well in Omaha that weekend. It also doesn’t hurt that the shareholders spent a lot of money on the products and services of Berkshire subsidiaries while in Omaha. Geico insurance, Dairy Queen, Pampered chef, Netjets and Fruit of the Loom are some of the 50 or so Berkshire subsidiaries. There was no sign of a recession in the Qwest Center Expo Hall and other Berkshire-related locations such as Borsheims Jewelers and Nebraska Furniture Mart.

There are tons of articles on the web describing each and every question asked at the annual meeting, so I am not going to cover all of them here. But I am going to mention a few that caught my attention. I am writing from memory so I might paraphrase a little.

Here are some memorable quotes:

“The goal is for the intrinsic value of Berkshire is to advance a few percentage points more each year than the Standard and Poor’s 500.”

"Our business doesn’t have contracts we don’t want relationships by contract."

Munger added, "Our model is a seamless web of trust that’s deserved on both sides. That’s what we’re aiming for. The Hollywood model where everyone has a contract and no trust is deserved on either side is not what we want at all.”

Warren answering a question on free cash flow said “Investing is about laying out cash to get more cash later. If you need a computer or calculator to figure it out, you shouldn't buy it. If you need to go out to the tenth decimal point to find the profit, it's a mistake.”

He also said that “if someone has an IQ of 150 and in the money management business, he should give away 30 points of that because it may not be necessary.”

“We have thought a lot about this (Executive compensation). In a capital intensive business you have to have a factor in a compensation arrangement that includes a capital -cost element. We have dozens and dozens of subsidiaries and we have different arrangements for different businesses because businesses that don’t require capital like See’s and Business Wire are different than business that requires lots of capital.

All in all the meeting was as I mentioned earlier was a cultural experience more than anything. It was great to meet with other investors who believe in the value investing and the Oracle of Omaha. Both Charlie and Warren did not disappoint the shareholders including myself. What I am struggling with now is the question about going to back to the next shareholder meeting or not. Although, it was a great experience, will the next year or the year after that be any different than this year and the year before? Are Charlie and Warren going to be as sharp as they were this year in the following years? It only remains to be seen. For my part, I think I am going to go back next year and see if I can pick a few more pearls of wisdom.

Be fearful when others are greedy and greedy when others are fearful

2008-01-23T12:04:00.000-08:00

"Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful."
Warren Buffett

We are definitely going through a very interesting time in our economy to say the least. Although there is great uncertainty in the markets, there also seems to be great opportunity. There is a difference between uncertainty and risk. Although, short term investors tend to mistake the two things, uncertainty and risk are not the same. Wall street hates uncertainty and punishes the stocks of good companies along with the stocks of bad companies. This creates a great buying opportunity for the long term investors. I am almost encouraged by this talk about recession. I have no way of predicting a recession or slow down or meltdown, what I do know is that Mr. Market is giving us a dicount on good companies. Instead of shunning stocks completely in down cycles, investors should add to their holdings or create new positions in stocks that have been on their watchlist.I have opened new positions in a couple stocks that I think have the ability to add to my portfolio in the long run. I have been watching these two stocks for about a year and this market decline has convinced me to jump right in and buy shares of these companies. I am buying stocks of companies that I think are best in their class and are trading at multiples much lower than they are truly worth. As Mr. Buffett says in one of his famous letters to his shareholders "be fearful when others are greedy and greedy when others are fearful".

Different Styles of Investing

2007-11-24T21:39:00.000-08:00

You will find Investors usually classify themselves into different categories like Value, Growth, Income, Small-Cap and International. But very rarely will investor classify themselves as short term investors. Almost everyone thinks of themselves as long term investors, even those that check share prices on their cell phones and have ticker symbols on their desktop never admit to being short term investors. Many people do not fall into any one category but draw from different categories to produce a diversified portfolio.

Value Investing
Investors that seek companies that have fallen below what they determine to be the real value or “intrinsic value” of the company. Since the stocks of the companies are selling at a depressed price, they are said to carry a “margin of safety”. Warren Buffett is probably the most famous value investor.

Growth Investing
Investors that invest in fast growing companies with a prospect for fast growth are usually growth investors. It is a much bumpier ride and this kind of investing is not for the faint of heart.

Income Investing
Income Investors usually invest in companies that pay dividend. Most of these companies are well established and have solid balance sheets.

Small-Cap Investing
Small cap investors invest in companies that have a small capitalization and relatively less known than the bigger companies. Since most of the companies are less followed by Wall Street analysts, the potential upside can be very substantial, but it comes with a lot more risk.

International Investing
International investors invest in companies listed outside the United States. More than half the world’s capitalization lies outside the United States.

Paying off your mortgage early vs. Investing in the Stock market

2007-11-23T21:14:00.000-08:00

Paying off your mortgage early vs. Investing in the Stock market

If you have ever wondered if you are better off paying off your mortgage early, you are not alone. Many people including yours truly have wondered if it is better in the long run to pay off your mortgage instead of investing in the stock market.

I have come to the conclusion that it truly depends on your time horizon. If you have a long investment horizon, and your mortgage rate is low, investing in the stock market is the way to go. Paying off your mortgage gives you a return of the interest rate that you would pay having the mortgage, i.e. if your mortgage rate is 6%, than your return for paying the mortgage off early is 6% as you are saving that interest on the principal over the term of the loan. You have to bear in mind also that if you pay off the mortgage you lose the mortgage deduction on your federal taxes. You also lose the leverage that real estate provides you. No one I know put 50% down on their homes, the most they put down for a payment was about 20-25% to avoid PMI. The rest was a loan from the bank or Mortgage Company. Furthermore, Real Estate is not the most liquid of assets. If you were to pay off your mortgage and somehow got yourself in a financial pickle, you may not be able to sell your house quickly. You could get a loan against it, but that would bring you back to where you started before you paid off your mortgage.

I understand that investing in the stock market with so many uncertainties like we have now is not easy. The fear of inflation, subprime fears, and geopolitical fears do not make investors sleep easy. But investing in the Stock market for the long term is the best way to creating wealth in the long term. So if you are not retiring in the next few months or years and do not have better alternatives to your money, don’t pay off your mortgage but invest your hard earned dollars in the Stock market and let the power of compounding do its magic over time.

Types of Brokers

2007-11-22T19:59:00.000-08:00

Brokers are generally divided into two large categories, Discount brokers and Full Service brokers.

Discount Brokers
Discount Brokers generally do not offer personal advice to individual investors; instead they make money by transacting business mostly online. Most Discount brokerages make money by doing business in volume, offering good customer service and low prices to drive more trades. The Discount Brokers usually offer a smaller number of products than full service brokers and keep their commissions lower to attract business. As an independent investor, I am a big fan of Discount Brokers. I have used TDAmeritrade and Etrade for many years and I am very pleased with their services. There are a number of other Discount Brokers like Scottrade and Sharebuilder as well, which are worth investigating before choosing a Discount Broker. Here is a link to a Broker Comparison Table at the Motley Fool website.

Full Service Brokers
Full Service Brokers usually offer a wide variety of services like Insurance, annuities, stocks, bonds and derivatives. They usually make money by either charging a percentage of assets managed or by taking a flat fee for the assets under management. The brokers who work for full service brokerages work mostly on commission and usually solicit their business. This usually means that it is in their interest to get their customers to trade. They make money whether or not the client makes money or not. I would like to mention that I have never used a full service broker myself and I am basing all the information above on my research. Large investment firms like Merrill Lynch and Smith Barney would qualify as full service brokers.

Since I believe in a do-it-yourself approach to investing and research, I recommend Discount Brokers. As I mentioned before, I have used a couple of discount brokers for the past few years and I am very happy with their level of service. With the explosion of the internet, discount brokers offer a lot more features than in the past, for instance TDAmeritrade offers free research from Standard and Poor’s stock report, which can be very helpful in making investment decisions.

Shelby Davis- A real life success in the stock market

2007-11-14T14:28:00.000-08:00

Shelby Davis was a legendary investor who turned a $50,000 account into a $900 million fortune over his lifetime. The secret to his success was not finding a few outstanding companies and betting big on them but instead, investing a few companies every year or so and then holding them forever.

Shelby rarely sold any of his positions and his portfolio had over a 1000 different stocks in it. Another of his trait was to stay close to his area of comfort, or in industries that he understood well. He invested a great deal of his portfolio in insurance stocks. He rode AIG for a huge profit from the very beginning of the company.

What is Free Cash Flow? and why do we care?

2007-10-30T12:02:00.000-07:00

Free Cash Flow is defined in a number of different ways as there is not a clearly defined term under the Generally Accepted Accounting Principles (GAAP).

I am going to attempt to explain Free Cash Flow in the best way possible but first why do we care about Free Cash Flow?

In simple terms Free Cash Flow is what is left over after a company pays all cash expenses and makes investments in capital equipment and working capital. So FCF (Free Cash Flow) is after tax cash flow available to all investors.

The way I learnt to calculate Free Cash Flow is start with the revenue and deduct all operating costs, arriving at operating profit. We then apply the tax rate to the operating profit. This gives us the net operating profit less adjusted taxes. To obtain FCF, we add back non-cash operating expenses, then deduct capital expenditures and investments in working capital.

Why do we care about FCF?

Free Cash flow is available to all claimholder’s on a business, both debt holder’s and shareholder’s. We care about Free Cash Flow because it helps us determine the value of company. Free cash flow or FCF helps us calculate the intrinsic value of a company, which we derive by calculating all future cash flows of the company minus the average cost of capital. So if you can buy the shares of a company at a discount to the intrinsic value, you are almost certain to make a profit.

I have learnt a great deal about this topic and other finance topics from the Motley Fool website and from the community boards. There is a lot of talk about Free Cash Flow at the Motley Fool website. Check out the following article on Foolish Fundamentals: Free Cash Flow.

Diversify, Diversify, Diversify

2007-10-19T12:35:00.001-07:00

What is the perfect number of stocks to hold in a portfolio?

In my humble opinion, there is no perfect number, it truly depends on the individual and their level of confidence in their own analysis.
For me that perfect number of individual stocks is 20. I will explain how I came to this number in a minute. But first, a Buffet quote to get us started.

"Wide diversification is only required when investors do not understand what they are doing"

Investor's with Warren Buffett's investment acumen can really get a bang out of their buck by only investing in a small number of securities, but for the rest of us, diversification is a necessity. Although, too wide a diversification can work in the opposite way and truly dilute the returns of a portfolio.

So how do you figure out what your magic number is? First you have to agree on the amount of time you can truly spend researching and analyzing the investments that you are going to be investing in. The magic number for me is 20. I can reasonably manage to read about and keep up with about 20 securities.

Here is how I have structured my portfolio. I invested 30% of the total portfolio in the Vanguard Total Stock Market Fund (VTSMX). Since this fund invests in the total stock market, this gives me immediate diversification. The next 10% of the portfolio is in cash and invested in a money market fund. The remainder 60% is invested in 20 stocks, that include blue chips, small caps and mid caps. This comes to an individual investment of only 3% percent in any one company. This gives me a cushion in case one of my stocks take a beating in the short term. If this happens I use the cash in the portfolio to add to my position, bringing down my cost per point on the security.
Here is how the investment portfolio breaks down:

VTSMX 30%
CASH MONEY MARKET 10%
Individual Stocks (20 stocks) 60%
______
Total 100%

7 Steps to Financial Security

2007-09-26T08:40:00.000-07:00

Step 1
Pay off Credit Cards and high interest debt

Step 2
Create a reserve account for Emergencies

Step 3
Buy Life Insurance

Step 4
Create a Will and Power of Attorney

Step 5
Start Investing in the Stock Market with an Index Fund

Step 6
Become a perpetual Investor and Saver

Step 7
Invest in yourself

Welcome to the Gamblers Ruin Blog and thank you for visiting us.

I have been a passionate investor for many years and I am a firm believer that there is no better place to increase wealth in the long term than the Stock Market. After reading a million plus words on other blogs, financial websites and books, I decided to start a blog of all that I have learnt or will learn in the world of investing and finance. I am using this medium to both investigate and comprehend the world of finance.

What’s with the name?

Gamblers ruin is a theory of probability that essentially means that if you play (read gamble) long enough, you will go bankrupt. The theory basically states that whoever starts with a larger pot has a greater chance of winning. Many people consider the stock market to be a supersized gambling machine with unbeatable odds. So Gamblers ruin was the perfect name to start a blog on finance. I truly believe that the stock market is NOT a gambling machine but a real vehicle for achieving long term wealth creation.

Where do I start?

I have made a list of Steps that are a good starting point for a journey to financial nirvana. Although, I came up with 7 to begin with, I am sure there are many more steps that make the journey even smoother. These 7 steps are:

Step 1
Pay off Credit Cards and high interest debt

This is a no brainer. If you have Credit Card balances that are outstanding with interest rates higher than 0%. Paying them should be the first step to financial independence. If you are paying interest on your balances, paying off your Credit Card guarantees that rate of return.

Step 2
Create a Savings or Money Market account for Emergencies

Calculate your monthly expenses into a dollar amount; this includes Rent/Mortgage, Insurance, Groceries, Utilities and other monthly expenses. Multiply this amount into 6 and you have your amount to be put into a Savings or Money Market account. This account is for EMERGENCIES only, like loosing a job or other real emergencies. This step is essential in becoming a good investor; if you have money for emergencies you are not likely to sell a stock that has lost a % of its value as the market gyrates downwards, when in reality you should be buying more of the stock.

Step 3
Buy Life Insurance

For people with families, this is a must do. If your employer offers a group policy at a reduced rate, that is usually the best deal in life insurance. Life Insurance is generally sold to people by an eager sales force, very rarely priced and bought by individuals themselves. The amount of Life Insurance depends on personal liabilities, debts that your surviving family members will have to settle or live with if you are to pass away. For e.g. Mortgage. For Single people, this may be an optional step.

Step 4
Create a Will and Healthcare Power of Attorney

Although talking about a will and Power of Attorney may give some people the creeps, this is a very essential step to becoming a master investor. Although there are many resources available on the web, like do it yourself kits and other software packages that generate a will using a template, this is a step best done by a professional or attorney who deals with estate planning for a living. It is worth the few hundred dollars to get this done by someone who is well versed in the laws of the State of your residence.

Step 5
Start Investing in the Stock Market with an Index Fund or ETF

According to the Oracle of Omaha, Warren Buffett, one of the best ways for new investors to invest in the Stock Market is through an index fund. The fund that I use is the Vanguard Total Stock Market Fund or VTSMX. This immediately diversifies a portfolio as it invests in the entire Stock Market. The rule of thumb when investing in the index fund or ETF is that if you are investing a certain amount per month, it is better to go with a fund, but if you are investing a lump sum, the ETF may be the best and cheapest way to go. The ETF for the Total Stock Market is VTI. The 5 year returns for the VTSMX are around 15.56%. Other ETF’s like SPY can also do the trick.

Step 6
Become a perpetual Investor and Saver

There is a power in perpetual investing; it helps take away the anxiety that may accompany investing in stocks for some people. Putting new money in each month into your portfolio, in good markets and bad creates for oversized returns in the long run. As many experienced investors have learnt that the best bargains are found in a bear market. The short term pullbacks can work to the advantage of the individual investor if you become a perpetual investor.

Step 7
Invest in yourself

As Ben Franklin once said, “An Investment in knowledge pays the best interest”. Investing in an advanced degree or learning new skills may add substantially to the pocketbook. In an environment where we are not only competing nationally but globally getting ahead may mean learning new tricks and becoming more valuable by educating yourself.